Y Ltd. produces energy drinks in different flavours. Due to high demand of its product, the rate of return on its earnings is 25%. Currently, the…

(b) The question can be solved with the help of Justified P/E Ratio linked to Gordon Growth Model. (i) Calculation of Retention Ratio P/E = 1-b K e -br 12 = 1-b 0.20-0.25b Or 2.4 - 3b = 1 - b Or 2.4 - 1 = 3 b - b Or 2b = 1.4 Or b = 0.70 or 70% So, Retention Ratio is 70%, if the company wants to maintain its P/E ratio to 12 in the current year. (ii) Calculation of Expected Price Per Share P/E = Market Price Share Earning Per Share P/E Ratio is 12 and EPS is 10 So, Market Price Share = P/E Ratio x Earning Per Share = 12 x 10 = 120 Retention Ratio is 70%, when P/E ratio is 12, Return on Earnings is 25% So, New growth rate = 0.70 X 0.25 = 0.175 = 17.5% Expected price after one year = 120 X (1+17.5%) = 141 Therefore, the expected price per share after one year is 141if Y Ltd. achieves the targeted P/E ratio of 12. (iii) Calculation of change in Retention Ratio P/E = 1-b K e -br 10 = 1-b 0.175-0.25b 1.75 - 2.5b = 1 - b 1.75 - 1 = 2.5b - b 1.5 b = 0.75 b = 0.75 1.5 = 0.5 or 50% So, Retention Ratio is 50%, if the company wants to maintain its P/E ratio to 10 in the current year.